Whilst there are benefits of forming a limited company, many people prefer to become sole traders instead. Working for yourself, without the limitations of shareholders and other directors, can seem like an appealing prospect if you want to run a company based on your own decisions.
There are approximately 3.2 million sole traders in the UK. This means that sole traders represent over half of the companies in the country, which could be set to rise in the coming years.
You may have come to the decision to set up your own business as a sole trader. Luckily, the process is fairly straightforward and gives you the flexibility and freedom that comes with being your own boss.
In this article, we'll look at what it means to be a sole trader, including how you register, what taxes you need to pay and how it can impact your tax bill.
Sole traders are individuals who run their own businesses on a self-employed basis. As a sole trader, you are able to keep all of the company's profits once the tax has been deducted. Any financial losses that the company make are also your personal responsibility, as there is no distinction between your finances and the company's finances.
You must register as a sole trader if you earn more than £1,000 in the tax year. It might also be beneficial for you if you need to prove that you are self-employed in order to claim Child Benefits or because you want to voluntarily pay Class 2 National Insurance payments to help you apply for other benefits.
Continue reading to find out how you can register as a sole trader and what this will mean for you and your company.
One of the first things that you need to do when registering as a sole trader is to pick a business name that you want to trade under. You can trademark the name, which means that no other company can trade under the same name.
There are certain limitations when it comes to naming your company. It cannot include terms such as 'ltd' or 'limited', feature offensive terms or be the same as another existing company. It can't suggest a connection to the government or local authorities either, unless you are granted express permission.
As a sole trader, you must also pay tax, which means that you have to register for Self Assessment. You can register via your business tax account, which you can log in to using your Government Gateway ID and password. HMRC will send you your Unique Taxpayer Reference (UTR) within 10 days if you are based in the UK or 21 days if you are based abroad. You will need your UTR to file your tax return.
Alternatively, you can register by completing and printing the registration form and posting it to HMRC. Your UTR will arrive within the standard 10 or 21 days, depending on where you are based.
Sole traders must keep certain records, including documents concerning their business expenses and income. This means that you will also need to keep records of your personal income as it is entwined with the income of the company.
There are several areas that you need to keep accurate records of including:
- sales and income
- business expenses
- VAT (if registered)
- PAYE
- Personal Income
- Grants (if claiming through Self-Employment Income Support Scheme)
These records are important to keep because they can be used to calculate your business' profit and losses and can be used by HMRC if they need them as a reference point. It's also necessary to keep proof of expenses and income, such as receipts for goods and stock, bank statements and sales invoices.
You can choose between two accounting methods for your records: traditional accounting or cash basis accounting. Businesses use traditional accounting methods to keep track of their income and expenses, such as using invoices to show the date attached to the transactions.
For example, you can use an invoice as evidence to show a transaction for the current tax year, even if the money is not paid to you until the following tax year. This is helpful if the invoice is recorded at the end of one tax year but the payment is made at the beginning of the next.
Traditional accounting means that you keep track of amounts that you are owed but haven't been paid, amounts that you are committed to paying but haven't yet and stock values. You will also need to keep records that show your bank balance at the end of the accounting year, the amount you have invested in your business and any money that you have withdrawn for your own use.
Small businesses that earn £150,000 or less can usually use cash basis accounting to record their income and expenses. This method means that you only have to record income and expenses when you pay a bill or money is paid to you. You won't have to pay Income Tax on expenses that you haven't been paid if it is not paid in that accounting period.
All sole traders are required to submit a Self Assessment tax return each tax year and pay Income Tax on their profits. You can file Self Assessments online using the Government Gateway. You can also use the online services to view the tax returns that you have previously made, as well as check that your details are correct and print your tax calculation for your own records.
You can complete your Self Assessment in multiple sittings if you are unable to complete the form in one go. The information will be saved on your account so that you can edit it at a later date.
You will need to notify HMRC of your income and the amount you pay in tax through a Self Assessment form. The tax return must be completed and sent to HMRC every tax year. Sole traders have to register for Self Assessment in order to pay tax, which can be done via the Government Gateway.
Tax returns do not have to be completed in one go. You can log in to your online account at another point and access your saved entry to complete the form.
The system is slightly different if you work in construction. The Construction Industry Scheme (CIS) means that contractors deduct money from the payments to subcontractors to pass onto HMRC. These deductions are counted as advance payments toward the National Insurance and tax that subcontractors need to pay.
Although contractors have to register for this scheme, subcontractors don't. However, the deductions will be made at a higher rate from the payments of subcontractors that aren't registered. You can register as a contractor if you pay subcontractors for work or if your business has spent more than £3 million on construction in the past year, even though your company doesn't do construction work itself.
You must register your company for VAT if its turnover exceeds £85,000. However, you can also voluntarily register for VAT even if your turnover is lower than this. Some businesses volunteer to pay VAT if they sell items to other VAT-registered businesses because they want to reclaim the VAT.
What are the benefits of being a sole trader?
Sole traders are able to start trading immediately because they don't need to register with Companies House as limited companies do. As a sole trader, the only thing you need to initially register for is self-employment for tax purposes. This will help HMRC to see how much Income Tax you should be paying through a Self Assessment form.
There is more flexibility for sole traders as there are fewer overheads. You are also the only owner of the business, which means that you are responsible for making all the decisions and don't have to pass them through directors and shareholders. This also means that you don't have to share the company's profits after tax and expenses have been paid.
You won't be required to file and record as much paperwork as you would in a limited company because the business isn't a separate entity. The only document that you are legally required to submit is the Self Assessment Tax Return and VAT (if you are eligible or voluntarily registered).
Your financial records as a sole trader will be kept private, unlike those of a limited company which can be accessed by the public via Companies House. Many self-employed individuals prefer this to their records being available for anyone to view.
If you decide you want the business to become a limited company, the process is relatively straightforward and easy. It is much easier to do than to change a limited company so that you run it as a sole trader.
Sole traders can claim tax allowances on business expenses such as office supplies, business premises and advertising and marketing costs.
What are the disadvantages of being a sole trader?
As a sole trader, you are fully responsible for your company's finances. This means that you will be responsible for any debts, losses and outstanding taxes that your business accrues. Your personal assets, including your house, may be at risk if your company encounters financial difficulties.
Some sole traders find it more difficult to trade than limited companies do because their business may not seem as trustworthy or reliable to potential customers. Limited companies are required to meet certain criteria that sole traders don't, which means that customers and other businesses may not want to buy from you. Some companies may even insist on limited company status before they will trade with you. The same can also be said for lenders, who may be more reluctant to offer loans to sole traders than they would limited companies. This is often due to the fact that sole traders' finances are private, whereas limited companies are available to the public.
Whilst it can be an advantage to be solely responsible for your business, this can also be a drawback too. You won't be able to share the responsibility with shareholders or other directors, which can put a lot of pressure on you.
Sole traders don't have as many tax planning options and opportunities as limited companies do. For example, you will have to pay Income Tax on profits that you have made in each financial year. Unlike limited companies, you cannot leave the profits in the business so that you can claim them in the following months.
Sole traders can also struggle to sell their business when they retire or move on to another job. This is because the company isn't a separate entity and requires an organised transfer of assets from the previous owner to the next.
You can register as a self-employed sole trader if you have decided that you would prefer to work for yourself rather than form a limited company or partnership. You will need to choose a name for your business that you would like to trade under, although there are certain words and references that you must avoid.
You will have to register for Self Assessment and Income Tax as a sole trader. A Self Assessment tax return will let HMRC know how much business income you make and therefore how much you should be paying tax on once tax-free income has been excluded. You may also need to register for VAT if you earn over £85,000 in a tax year or if you voluntarily register for VAT.
As a sole trader, you have to keep certain records when trading, including evidence of your sales and income, business income and your Personal Income. These records can help you to calculate your business finance from sole trading, such as gains and losses, as well as help HMRC when they collect Income Tax.